A propensity to hope and joy is real riches: One to fear and sorrow, real poverty

— David Hume

Kuwait and oil are not the same ting (sic)

— Fat Tony (“Anti-Fragile”)

Managers are infatuated with costs. Walk into most organizations and the language you’ll hear around the workplace is indicative of the cost-based culture they operate in. “Budgets”, “timesheets”, “estimates”, “resource/capacity planning”, “estimated time to complete (ETC)”… they’re all hitting on the same note, like a badly tuned piano in a dusty, smokey bar.

Yet the last three decades of management thinking have been repeatedly pointing organizations in the opposite direction - focus on revenue growth and value generation, that’s how companies ensure long-term success. Cost-cutting, beyond the “stop flying around in first class and having lunch in Michelin starred restaurants” type, will at best provide you with short-term gains. At worse, they will sacrifice the future of your organization.

Still the cost-based management culture continues to be widespread. Why?

For starters, cost-cutting gives immediate effect.

Don’t under-estimate the pressure to deliver short-term results in any organization. It takes real vision and emotional fortitude from leaders to be willing to withstand sacrificing the short-term to ensure long-term success. And no, I’m not suggesting we just ignore all short-term results. What I am suggesting is that they are not the most important thing. Leading an organization is a game of survival as much as anything else. And to survive, a leader must balance a lot of opposing topics.

Long-term vs. short-term.

Innovation vs. predictability.

Value vs. cost.

Trust vs. control.

Purpose vs targets.

And none of these conflicting views has a clear, definitive way to handle them. It depends on context, as always. But if your organizational leadership consistently leans on the right-side of those topics, it might be time to start working on your LinkedIn Profile and polishing up your interview skills.

And if you’re an investor and the company you’re looking at leans strongly to the right… run. Unless you’re an algorithm, investment should be a long-term game and right leaners will struggle in the long-term. The last thing you want is your hard-earned cash tied up in an investment where you’re betting leadership will finally, this time, realize the error of their ways.

Still, that being said, there is definite pressure for short-term results. And you know the easiest way to deliver short-term results? That’s right, cut costs. All else remaining equal, if you manage to reduce costs by 5%, your profits will go up accordingly. So it’s obvious why so many focus on it. It’s like steroids, cheating on an exam, bribing, or cutting in line. It’s a short-cut to avoid the real work.

The fact it’s so easy, should be warning. There has never been a free lunch.

Also, it’s much easier to work with costs because you can easily measure them.

Just count the money that goes out every month. That’s it. You don’t need to understand the intricacies of the market, the gradual (or violent) fluctuations in your customer’s preferences, or the inner workings of your organizational culture.

Value, on the other hand, is much harder to measure. You could just count the money coming in every month, but that’s counting the value generated by a previous investment. And you’re rarely sure which one. Cost is immediate, value is not - it trickles in over time and depends on so many variables that all you can do is take some educated guesses about what caused it.

Of course, accounting experts can spin all of this on its head. An accountant will tell you that you can spread out costs over time and collect future value today using mark-to-market accounting. That’s because a great accountant doesn’t tell you what your numbers are, he asks you what you want your numbers to be. But let’s not go down this rabbit hole right now.

The bottom line is simple - costs are immediate and easy to measure. Value comes sometime in the future and is hard to measure. Sometimes, value is not even represented by money coming in (e.g. brand recognition, innovation, reputation, …). And that’s one reason that most managers like focusing on cost - it makes them feel like they can manage something. In the cost world, there is a reaction to each and every action, and their causal relationship is self-evident and reassuring. Or at least it seems that way, until you realize that…

Managing costs also have hidden effects, some of which are hard to predict

What is the cost of outsourcing your development activities? The cash part of the equation, as mentioned above, takes little more than 5th grade math skills to figure it out. Just see what you were paying your on-site developers before, subtract that from what you will be pay your offshore developers and voilá, you have your monthly savings. Factor in the cost of actually firing people (severance packages) and you can easily see when the move has paid for itself. Simple, right?

Not so fast, Jack. Even though outsourcing companies would like you to stop there (and short-term focused managers will happily abide), the rabbit hole goes a bit deeper. You can start with simple things such as the additional time (and money) will you spend on aligning offshore activities with onshore goals. But you can easily go into more complex terrains - what about the loss of motivation from your employees who liked working with their local developers? What about the lost tacit knowledge? What about the fact that the people who now know the most about how your product/service actually works are no longer your employees? What about asking why your outsourcing partner can have such low prices? Maybe you gave up something else along the way…

Cost-cutting is a fragile strategy. It forces additional focus on process, standardization and compliance, which makes you vulnerable to any variability or unforeseen events. Because of the evident impact of cost-cutting on the bottom line, it creates a myopia in managers who over-estimate the financial benefits and under-estimate the unintended consequences.

Cost-cutting is management’s opium den, providing them escape from their inability to generate value. Over time it slowly kills their connection to the real world and they are caught in the endless loop of the addict, desperately looking for next high and finding any justification to excuse the behaviour.

There is a limit to how much you can reduce costs; there is no limit to how much value you can generate

If leading a company is a game of survival, guess who survives in the long-term? The company cutting every corner possible to reduce costs or the company who manages to find a value-niche and colonize it?

You can improve the profitability of your company in two ways - growing the top line (revenue) or reducing costs. The efficiency fad of the 20th century has wrecked holy war on costs for long enough. The body count is high enough. Every manager should just put down the red marker, take a deep breathe and ask themselves a question that can be equal measures of exhilaration and fear - “what can I do to help the long-term, sustainable, top line growth for this company?”

Exhilarating, because you’re joining the value-side of life, and it’s more fun over here. Scary because you might not find an answer, at least right away. And it will take courage to explore this line of thinking further. But this, my friend, is a rabbit hole worth going down.